Central banks hold reserve currencies for a number of reasons, and the choice of which to hold can be based on a several factors. Historically, gold, pound sterling and the dollar were all accepted as satisfactory forex reserve instruments at various points in time for most central banks. In recent years, many central banks have expanded the list of currencies held in their reserves reflecting diversification in trade and a greater internationalisation of the financial system. The list of common forex reserve currencies now includes not only the SDR constituents but also Swiss franc, Korean won, and the Australian and Canadian dollars.
Many central banks are now more cautious or are rethinking their currency allocations based on the additional objective of geopolitical risk avoidance. There has been much discussion around the displacement or replacement of the dollar with a variety of other options. By almost all metrics, the Indian rupee should be considered a strong candidate to be included as an additional currency and government bond portfolio within most central bank reserve allocations.
There is increased urgency in this discussion. Since 2022, the Reserve Bank of India has allowed the invoicing of trade in rupees and has implemented a facility for trading partners and central banks to hold an onshore vostro account that allows the proceeds to be invested in Indian government bonds. The inclusion of Indian bonds in popular emerging market bond indices in 2024 is also acting as a catalyst and prompts our closer look at the fundamentals of the currency to examine whether it satisfies some of the basic criteria for inclusion in a reserve portfolio.
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